Lessons in Investing: Accuracy vs Precision


“Lessons in Investing” is found in our Forum for subscribers. Here is a special public edition.

 

Many people do not take the time to think about the difference between accuracy and precision for traders and investors. While the definitions are essentially similar, there is a subtle difference between the two as I see it and treat it.

Accuracy to me means getting the general idea right. Precision is not only being accurate, but getting the fine details, meaning trade entry or exit, very right. In essence, precision means more perfect execution.

Being almost perfect is very hard. That’s what makes trading so difficult and why most people fail at it. Not only do you have to have to be accurate about something, but you have to precisely get into and out of a trade. And pretty much as a rule, the trade is something that very few others are doing, so there are few guideposts, meaning we have to figure out the details from scratch.

An example of accuracy without precision:

Last summer, I was one of the very few people to say and publish to get out of oil stocks because oil was going to drop significantly. I was right. That’s accuracy.

The outcome for me was good, but it wasn’t great or life changing. I did avoid taking losses on stocks like Whiting Petroleum (WLL) that I had bought back in 2012 when I was pounding the table about the fracking boom (again, before most others caught on, so more accuracy in my opinion). In fact, I preserved some big gains. But I didn’t get rich, and I could have. Why? Because I saw something few others did.

What I didn’t precisely do, despite accurately stating the case for a big drop in oil prices, is put together a great trade for that scenario. If I had, I’d likely be writing to you from a beach front somewhere.

The trade that was available to most people was to buy puts on the oil ETF USO (probably on OIL too). Back in June and July of 2014, when the price of oil per barrel was over $100, you could buy $90 strike price and $80 strike price puts on USO for single digits to a January 2015 expiration. The price of oil the day before the USO contracts expired was $46.37 per barrel (EIA website). Had I bought those puts I would had made a big killing and an uber-mega-oh-my-gawd killing. Alas, I didn’t and I am today in my office in Elm Grove, Wisconsin, which is nice, but not quite like sitting on a patio or balcony overlooking a beachfront ocean with my laptop I imagine. 

I did make a small futures trade, and recommended that trade to a few accredited investors. We made about 27x our money on betting the price would drop below $90. I should have done more than a tester $1000 trade. The $90 based contracts were quite a bit more expensive than the $80 futures, but seemed more certain, so we didn’t even bet on a decline to below $80, even though in my article I said it would probably happen and made allowances for it crashing through that level. Had we made the bet on $80 oil when it was over $100, we would have made over 100x our money. Live and learn. Crazy trades right?

My failure at putting together a precise way to capitalize on an accurate idea cost me a lot. The logical follow through of my thought process was to put together a strategy for the idea.

Why didn’t I? In a word, fear. An old opponent, but one that keeps coming back and winning battles. This time, it kept me from making literally millions. 

What did I learn from not becoming very rich last year?

Well, the first think I learned was that there are a handful of trades out there that are legitimate life changers. The types of trades that don’t just double or triple our money on what we invested, but that can add zeros to our accounts. I have known about these types of trades since the tech crash. It’s important that we acknowledge the improbable so that we don’t think of things as impossible.  

The second thing I learned is that if I have a big idea that I am convinced is accurate, take the time to look for the home run trade. Follow through on a different idea that is likely to be right is a vital component for a trader or investor. Putting together the home run trade will require precision, and it is likely to be high risk, but, it could be life altering if I get it right. Making the home run trade or investment takes accuracy and precision. 

Thirdly, and not something I’ve learned recently, I learned this a long time ago, is be very careful about position sizing. It rarely makes sense to put a double digit percentage of your money into one holding. Ever. Risk management above all else. 

Next Lesson: “Putting the calendar on your side.” (which will be in our forum section for subscribers)